Tutorial 2 Flashcards
Office Company reported earnings per share of $2.40 and paid dividends per share of $1.06. Over the last five year, this company’s earnings had grown 7.5 percent a year, and were expected to grow at 6 percent a year in the long run. The beta is 1.05 and the average market return is 12.5%. The Treasury bond rate is 7 percent. Estimate the P/E ratio for Office Company.
In July 2019, The Walt Company’s stock had a beta of 0.95. At that time, the Treasury bill rate was 5.8%, and the Treasury bond rate was 6.4%. The debt outstanding was $1.7 billion and market value of equity was $1.5 billion; the corporate marginal tax rate was 36%. Assume that the geometric average market risk premium is 5.5% and the arithmetic average market risk premium is 8.76%.
If you are a short term investor what is the return on the stock?
In July 2019, The Walt Company’s stock had a beta of 0.95. At that time, the Treasury bill rate was 5.8%, and the Treasury bond rate was 6.4%. The debt outstanding was $1.7 billion and market value of equity was $1.5 billion; the corporate marginal tax rate was 36%. Assume that the geometric average market risk premium is 5.5% and the arithmetic average market risk premium is 8.76%.
If you are a long-term investor in the company, what is the expected return on the stock?
In July 2019, The Walt Company’s stock had a beta of 0.95. At that time, the Treasury bill rate was 5.8%, and the Treasury bond rate was 6.4%. The debt outstanding was $1.7 billion and market value of equity was $1.5 billion; the corporate marginal tax rate was 36%. Assume that the geometric average market risk premium is 5.5% and the arithmetic average market risk premium is 8.76%.
Estimate the cost of equity for the company
- The cost of equity for the company is more appropriately the longterm required rate of return, since most projects for the company
would be long-term. - Cost of equity=11.63%
Alpha Corporation has debt outstanding of $1.7 billion and a market value of equity of $1.5 billion; the corporate marginal tax rate was 36 percent.
Assuming that the current beta of the stock is 0.95, estimate the unlevered beta for the company.
Alpha Corporation has debt outstanding of $1.7 billion and a market value of equity of $1.5 billion; the corporate marginal tax rate was 36 percent.
How much of the risk in the company can be attributed to business risk and how much to financial leverage risk?
The proportion of the risk of the firm’s equity that can be attributed to business risk is 0.55/0.95 = 58%, while the rest is due to financial leverage risk.
Estimate the Cost of Equity for the company
Now assume that the company plans to sell off its housewares business, which accounts for 40% of the current value of the company and hold the cash. If the unlevered beta for housewares is 0.65, estimate the cost of equity for the company after this transaction.
Solve for Cost of Eq. using CAPM with the Bu from below
- First, we calculate the cost of equity for this B&B business.
Cost of equity (𝑟𝑒)= 𝑟𝑓 + 𝛽𝑖 *(𝑟𝑚 –𝑟𝑓)
𝛽𝑖 =market beta/sqrt (𝑅^2)=1.25/0.5=2.5
Cost of equity (𝑟𝑒)= 𝑟𝑓 + 𝛽𝑖 *(𝑟𝑚 –𝑟𝑓)
=0.015+2.5 x 0.06 =0.165=16.5%
Because this B&B business has no debt,
𝑟𝑤𝑎𝑐𝑐 = 𝑟𝑒 =16.5%
Genting Inc. is an Indian conglomerate with holdings in tourist resorts. The beta estimated for the firm, relative to the Indian stock exchange, is 1.15, and the Indian market premium is 12% (default risk adjusted).
Long-term government borrowing rate in India is 8.5%. The Indian government had a sovereign rating of Baa3. Assume that the default spread for Baa3-rated government bonds is 2.5%.
Estimate the expected return on the stock.
𝑟𝑖= 𝑟𝑓 + 𝛽𝑖 x (𝑟𝑚 –𝑟𝑓 )
=(8.5%-2.5%) + 1.15 x 12%
=0.198=19.8%
Genting Inc. is an Indian conglomerate with holdings in tourist resorts. The beta estimated for the firm, relative to the Indian stock exchange, is 1.15, and the Indian market premium is 12% (default risk adjusted).
Long-term government borrowing rate in India is 8.5%. The Indian government had a sovereign rating of Baa3. Assume that the default spread for Baa3-rated government bonds is 2.5%.
If you were an international investor, what concerns (if any) would you have about using the beta estimated relative to the Indian index?
For an international investor, who has the ability to diversify globally, some of the risk might be diversifiable, and hence the true beta might be lower. To take care of this possible overstatement, it would be
appropriate to compute a beta relative to a more global index.
